International Finance Assignment
Introduction -
You will be asked to perform a task which will provide you an opportunity to exhibit your understanding of the theories in international finance. More specifically, you will need to collect FX quotes and use these quotes to develop an exchange rate forecasting model and predict the short term exchange rate.
Tony is a venturesome engineer who is your close friend and also a poker buddy of yours. Tony and his partner Maureen have planned to travel around the world. While they were busy planning the details of the trip Tony had asked you to help out with preparing for the travel.
When Tony heard that you had enrolled in an 'International Finance' course he suggested a bet on whether you would be able to guess the AUD/CAD exchange rate until Tony returns at the end of March 2017.
Winning the Bet -
To win the bet Tony has offered prediction criteria you must meet in order to win the bet:
1. The prediction of the exchange rate starts from the second quarter of 2015 till the first quarter of 2017.
2. A total of 8 predictions should be made for the exchange rates for the last trading day of each quarter.
3. The prediction of the exchange rate must be made by using market data available one quarter (3 months) prior to the quarter you are trying to predict. For example, if you are predicting the exchange rate for the first quarter of 2017 you can only use data available until the last day of the previous quarter (fourth quarter of 2016).
4. You have to setup two prediction models. One of the models should use a regression analysis, whilst one of the model can be any method of your choice.
5. In the regression analysis, the inflation rate and the risk free interest rate (cash rate for AU, target overnight rate for CA) for the two countries must be used to generate the independent variables. Three additional independent variables are required with appropriate justification of the need for such variables.
6. The average estimation error must be less than 1% for both exchange rates for you to win the bet. (Note: whether you win or lose the bet is not marked)
Market data -
You decided that the bet with Tony was a good opportunity for you to try predicting the future exchange rates and implement a speculative strategy. At the end of the first quarter of 2017 (31 March 2017), you checked the current FX quotes for the spot and forward rates for the two exchange rates. The quotes were as below.
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Table 1
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CAD/GBP
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AUD/GBP
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31 Mar 2017
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Bid
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Ask
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Bid
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Ask
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Spot
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1.6310
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1.6390
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1.5893
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1.5953
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1 Months Forward
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8
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9
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35
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36
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2 Months Forward
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17
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18
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67
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68
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3 Months Forward
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24
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26
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100
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101
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6 Months Forward
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45
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48
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193
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196
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1 year Forward
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63
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73
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348
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356
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With your current credit rating you can borrow up to 1 million Pounds Sterling (GBP). The spread over the risk-free rates for your credit rating of A had the following spreads.
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Table 2
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Country
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AUD
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CAD
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GBP
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Spread (Loan)
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3.000%
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2.000%
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1.500%
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Spread (Deposit)
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2.500%
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1.600%
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1.250%
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Required: Questions to answer
In your 2,000 word report you are to provide information of the following:
1. Explain the prediction model(s) you have established. Explain how you collected the data for the models and what issues you faced in selecting the data.
2. Provide 8 predictions for the AUD/CAD spot exchange rates calculated from your two models from the second quarter of 2015 till the first quarter of 2017.
3. Compare your prediction with the actual AUD/CAD spot exchange rate. Reflect on your forecasting model by evaluating the performance of the prediction models. Did you win the bet?
4. Discuss how you can improve the predictability of your models.
5. Using the forecasted spot exchange rate from your prediction model and the FX quotes from table 1 and 2, propose a speculative strategy in the FX market?
6. Can you find any patterns using technical analysis in the AUD/CAD exchange rates during the first quarter of 2017?
Make on excel 2016 and report should be of 2000 words.
Attachment:- Assignment Files.rar